The growing scope of one-belt one-road in Pakistan

We first covered China’s growing ambitions in Pakistan in early 2015 here. Since then, much has transpired and the plan has increased in scope. One Belt One Road (OBOR) or 一带一路 (Yī Dài Yī Lù) has gotten more and more attention (it was People Daily’s most discussed topic in 2016[1]), and for Pakistan it has become an increasingly significant partnership with China.

Without mincing words, the plan and the scope of its spending in Pakistan essentially forfeit Pakistan’s sovereignty to China. There is no debate here. Where there is room for debate is whether this is in Pakistan’s long-term interests. We do not agree with people such as Christine Fair from Foreign Policy who contend that this arrangement is against the long-term interests of Pakistan. We think the most relevant example is South Korea. South Korea in exchange for many benefits, entered a partnership with the United States that remains to this day, post-Korean war. In that time, South Korea went from the backwater of the Korean peninsula to one of the wealthiest countries in the world. A hub for innovation and a leading exporter of culture. This is important because it suggests that Pakistan can maintain its own culture, and perhaps enhance the influence of its cultural products through its alliance with China.

Dawn, Pakistan’s leading newspaper did some impressive investigative journalism earlier this year and found the full document that lays out China’s plans for Pakistan. It was only given to Pakistan’ most populous and powerful province, Punjab. Other provinces simply received a summary of the full document. We do not believe that investors outside of Pakistan are even aware of this document and thought those interested in Frontier Markets would be well-served to focus on this document and its implications for future development and growth across the world. Unfortunately, Dawn has not provided the document for others to access, but they do provide an extensive commentary here.

Current status

Before we go into future projects outlined in the initiative, it is helpful to look back over the past two years and see what the status of the project is. Pakistan’s GDP is expected to grow to $300bn in nominal terms by the end of 2017, which is 23% higher than at the end of 2014. GDP per capita during this time has gone from $1,364 to an expected level of $1,558 by the end of the year. In comparison, India’s GDP per capita is expected to be $1,850[2] by the end of 2017.

The IMF is reasonably satisfied with how Pakistan’s government has been managing its finances, and we look to be well-positioned for Pakistan’s 2nd peaceful election after two full terms by democratically-elected leaders. The election will be held in mid-2018 and we are optimistic that it will be concluded with a firm mandate for the victor.

Construction across Pakistan has been robust, only three of the tallest buildings in Pakistan are more than 10 years old. Pakistan consumes about 25,000 megawatts (MW) per day of electricity, but has demand for approximately 30,000MW and growing at 10%+ annually. On Thursday, the Sahiwal Project was inaugurated, a new 1,320MW coal-fired facility that will help bridge the 5,000MW deficit that exists today. It was built in 22 months, the fastest-ever in Pakistan, and a strong indication of what China brings to Pakistan[3].

There ae over 100 initiatives currently under construction including the reconstruction of the Karakoram Highway which connects Pakistan and China by road. We took the highway in 2007 shortly after the 2006 earthquake ravaged the area. It is the highest altitude border crossing in the world, it is so harsh that the actual customs and immigration for both China and Pakistan are several kilometers within each country, respectively. Our photo below provides an indication of the raw beauty of the area but also the precarious conditions (the ‘road’ is on the right). This will be entirely changed by 2020.

Lahore Metro, Pakistan’s first subway will be open by early next year. Similar projects are underway in Peshawar, Rawalpindi and Karachi with China’s assistance[4].

The Chinese have begun to enter Pakistan in droves, be they as tourists or permanent residents. In Balochistan, where the Gwadar port is operated, approximately 600,000 Chinese have been coming in annually over the last three years, if current trends persist there are concerns of local Balochis being outnumbered by the Chinese[5].

The rationale

One of the things that we also feel is missing from the conversation is a full understanding of the rationale for OBOR from China. OBOR was first announced in 2013. Premier Li Keqiang first cut the growth rate for China in 2013 to 7.5%, it was then changes to 7% in 2015 and 6.5% in 2016. China in 2012 realized that it could no longer grow via the development and investment in infrastructure and construction. China in 2012 had arguably the best highway system in the world and most certainly the best railway system in the world. Airports were and continue to be upgraded in places that won’t need that level of service for decades. Domestically, the shift began to developing consumption within the economy. However, in building China, the Chinese had developed world-class expertise at large-scale construction inexpensively and of adequate to good quality.

Rather than facing the prospect of retraining tens of millions of workers and redirecting them towards other industries, China had a flash of brilliance, that we believe will be one of the smartest political gambits of our time. In one fell swoop, China can put all its workers in the construction industry to work, it can build and develop markets for Chinese goods, and it can use cheaper labor for low-level manufacturing in foreign countries as Chinese workers become increasingly expensive. It is important to remember through all of this, that Chinese investment programs are not financed via a grant, the funding comes from low-interest or interest-free debt. Regardless, China will essentially receive all these benefits for free, using surplus assets.

There are an estimated 1 million Chinese working in Africa and a similar amount all across Asia[6]. There are then, of course, those Chinese who are sent towards China’s borderlands to shore up construction there, be it the Pakistan-China border or the Laos-China border. In 2016, we also saw a 3,700% increase in tourist applications for Chinese citizens wishing to visit Pakistan[7].

Findings from Dawn’s exclusive

Hopefully, we have provided you with two key insights, China is acting methodically and innovatively, and that these are mere words like so much of Western policy has been over the past 50 years. It is further evidence that when China sets a policy in motion, its big machine engages into action at a scale and pace that is difficult to comprehend as there are so few parallels in all of human history.

Dawn’s commentary provides a few noteworthy insights that we think it is worth spending some time on.

Agriculture

The most interesting finding is the extent to which OBOR is focused within Pakistan on agriculture. To date, most of the press and government announcements have focused on electricity and transportation, very little has been made of agricultural ambitions. It is our view that China sees Pakistan as a future breadbasket for Western China. Xinjiang and Tibet are essentially bone dry. Thousands of years of irrigation has even removed groundwater supplies and there hasn’t been enough rain without using nonrenewable sources like groundwater for centuries. Pakistan in comparison has its share of issues but remains quite fertile. There are significant geopolitical issues at stake here as Pakistan and India are currently on the verge of major disagreement with respect to India’s dam construction that Pakistan purports is against the Indus Water Treaty[8]. If India restricts the flow of water to Pakistan through dam construction this would likely lead to a major conflict. China’s dependence and involvement in Pakistan’s agricultural economy take the risk of disagreements or water flow and makes it a global concern.

The potential to solve poverty within Pakistan is also material as over 50% of Pakistan’s agricultural output goes bad due to problems with harvesting and transport. Using Chinese technology to automate and scale farming within Pakistan is likely to have a long-lasting benefit to the country. The plan sets forth large-scale projects such as a 200,000 ton per year meat plant in Sukkur, a 1mm tons per year grain processing plant in Lahore and fruit juice processing in Islamabad. It is remarkably detailed and well thought out.

Industry

For industry, the plan divides the country into three zones, see the map below.

Karachi is imagined as a hub for steel, iron, machinery, and auto manufacturing due to the vicinity of ports. Textiles are a key area of interest, an area in which Pakistan is already a world leader.

Infrastructure improvements are also included with respect to fiber optics and security.

Thoughts

It is certainly an aggressive action from China to pursue OBOR, but we also think it’s in the country’s long-term interest in much of the same way that reconstructing Europe after World War II was in the United States’ interest. There are of course concerns about increasing power for China, but that is an inevitable outcome in our view. When you look at the rising heft of China’s technological sector, the vastly improved quality of education in China and the power gap left by the election of Donald Trump, fighting China’s rise is folly. However, the increasing economic dependencies between all these countries makes conflict for more unlikely in our view. Russia’s conquest of Crimea would have certainly produced an armed conflict with other European powers two or three centuries ago. The mutual economic benefit afforded by refraining from violent conflict, however, is far too appealing to both sides.

We have profiled Pakistan several times. If you would like to read up on how to invest in the country, you may read this[9]. Of course, Pakistan is now part of the MSCI EM meaning it is easier to get exposure than ever[10].